Reverting to market mean

As far as investment yarns go, there are few that I love more than an old “reversion to mean” parable.

Markets have run too hard, shot too high? Surely, they must settle back for a while. Asset prices have been in the doldrums for an aeon? They’ve got to bounce back. They just must.

In the past decade, we’ve seen it in Perth’s property market. Real estate ran too hard for too long, on the back of a strong resources sector.

After the boom, property prices got flushed. They have been stuck in the S-bend for some time and are now truly stinking up the joint.

But they will, absolutely guaranteed, take off again. Sometime.

The million-dollar question I know you want the answer to is: “When?”

Bear with me. I’ll answer the question honestly.

What happens eventually to all markets is what’s known as “reversion to mean” – that is, they will, at some stage, come back to somewhere near the long-term average growth rate that they have bounced around on either side for, usually, decades. If they run too hard for a period, they will slow down or go backwards for a time. If they’ve been going backwards for a period, they will, eventually, taxi to the runway and take off, often quite quickly.

Reversion to mean means both that you can’t hold a good thing down forever and also that a good thing can’t continue to rise exponentially forever.

Perth property (like shares) is a cyclical asset class. It’s not dead. It’s just been on the mat for a while.

“Thanks Debt Man. Seriously. When?”

What drives property prices? A multitude of factors. Supply of and demand for, fundamentally. And these take into account factors such as population growth, income growth, employment levels and more.

Only at the peaks and troughs does it have anything to do with with exuberance and speculation, or their opposites pessimism and capitulation.

If you’ve been considering diving into the property pool, what signs should you be looking for?

That really depends on what sort of property buyer you are.

First home buyers, I’d argue, should buy when they can afford to buy. If that’s now, then go ahead. Prices are a lot cheaper than they were three years ago.

Don’t worry about trying to pick the market’s bottom. You don’t know what you’re doing. You might miss it. If it moves quickly again, you might get priced out.

If you’re an upgrader … what does it really matter? If your current home’s price has fallen a bit over the last three years, then so too (in all likelihood) has your target property style. That is, if you’re moving from a two-bedroom house to a four-bedroom home to accommodate some tin lids, then in relative terms, the fall in the value of your current place is likely to have been matched by a similar percentage fall in the typical four-bedder that you’re considering.

The only real issue for you here is if your equity has been eaten up.

Essentially, for those buying homes to live in, capital growth isn’t the main game. It’s about living where you want to live, being near family or friends or the kids’ schools and enjoying your lifestyle.

But, to the investor, capital growth is EVERYTHING. Stagnant or falling property prices are death. Market timing is important.

If an investor paid $500,000 for a property and a decade later it was only worth $450,000, that’s a financial disaster – worse if they had also been negatively geared (ouch). A cash investment would be worth around $670,000 (at 3 per cent).

Thousands are smarting over a mis-timed purchase in Perth’s market from a few years back.

“Yep, gotcha. So when will that be?”

My honest answer? Here you go: I don’t know.

And neither does any expert who is being honest. If they did, they’d pin their ears back, borrow until their nose bled, and buy.

But if you are in the market for a Perth property, I’d be getting my finances in shape. Perth property appears ripe for a reversion to mean some time in the next year or two.